Markets have had their hands full processing the gravity of Russia’s invasion of Ukraine.
Now, we’re trying to wrap our minds around a rapid social boycott of Russia. In the past week, we’ve seen wild moves in oil prices, stress in global markets, and major companies sever ties with Russia. We’ve effectively cut off the world’s 11th-largest economy in a matter of days.
While that may be an appropriate response, the boycott of Russia has opened a whole new box of risks, questions, and reactions. If every action has a consequence, then what consequences are we overlooking?
Let’s untangle this complicated web.
The contagion risk
First, we need to talk about financial warfare’s impact on Russia. The country no longer has access to much of its $630 billion in international reserves — essentially money held abroad — and a few Russian banks were kicked off the SWIFT global messaging system.
These drastic moves have sparked financial panic locally. The ruble suffered one of its biggest drops in history, and the Russian central bank couldn’t do as much to stem the bleeding. On top of that, Russian assets have been shunned by the rest of the world, and global markets have swung dramatically as investors have moved their money out of Russia-related stocks and bonds.
But before you start to panic, let’s differentiate between economic and financial risk. Russia (and Ukraine) are small players in the scope of the global economy. Russia accounts for about 1.8% of global GDP, and it supplied less than 1% of the US’ total imports last year. Several economies, including the US, could conceivably function independently of Russia. It’s a different world than in 1998, when Russia’s bankruptcy dragged down global growth and fueled a nearly 20% S&P 500 selloff. That’s comforting news.
However, the global financial system is more connected than ever. Big market moves rarely happen in isolation these days — they tend to ripple through other markets and roil portfolios of big investors like banks and hedge funds. Wall Street calls this “contagion” risk.
My view: The financial world has been slowly disconnecting itself from Russia over the past several years. Those efforts may be saving the financial system today. Yes, we’re reading headlines about situations like Citigroup’s $8.2 billion exposure to Russia. But overall, Russia has claims on less than 1% of loans in the global banking system. The US makes up less than 1% of those claims. European banks may be more at risk: They hold more exposure to Russian bank claims given they’re all close neighbors, but this may just cause issues for a few banks in that region.
The oil predicament
Right now, the most important bargaining chip for Russia is oil, given it’s one of the largest oil exporters in the world. Oil prices have surged to an 11-year high, and even though oil and gas activity hasn’t been blocked by sanctions yet, the demand for Russian oil has evaporated. That could keep oil prices high for a while, which means inflation may stick around.
To make things even more complicated, the Federal Reserve is managing an economy that may be more at risk for stagflation, the dangerous combination of high inflation and low growth. And Fed Chair Jay Powell is prepared to make moves. On Wednesday, he insinuated that the Fed will raise rates in some form at its next meeting. The Fed has a lot of balls in the air, and consumers are starting to get fed up with higher prices.
My view: Oil’s rise could be the biggest risk for everyday investors. The US economy is in a tough spot with inflation, and with oil’s spike, prices could stay higher for longer, regardless of what the Fed does. On the bright side, high gas prices could force more adoption of substitutes, like solar power and electric vehicles. That’s a big reason why solar stocks have rallied 14% since the invasion started.
The company boycotts
It’s not just countries. Companies are also withdrawing from Russia en masse. Apple, FIFA, Disney, and Exxon are just a few familiar names that have said in the past few days that they’d sever business ties with Russia.
It’s a noble effort, yet the costs could add up quickly as many companies stomach losses from the sudden divestment. It’s easy to forget that a market is made up of stocks, and if enough stocks are impacted by something, the market will likely follow suit.
Luckily, the vast majority of US companies don’t do business with Russia, even though ones that do have been thrust into the spotlight. Only nine companies in the Russell 3000 reported revenue from Russia last year, and they’re down an average of 8.3% this week. The hidden risk, though, may be US’ companies reliance on global business in general, especially in Europe. About 19% of all Russell 3000 companies generate revenue in Europe, and since Europe is a bit more entangled with Russia, its economy could take more of a hit.
My view: US profit growth may be strong enough to weather some weakness. But there’s still the lingering question about how much friction US companies can handle with the economy downshifting and inflation staying persistently high. If you own single stocks, it may be wise to figure out who their suppliers are, and which regions they do business with. Energy stocks are an especially interesting case these days. While energy is by far the best-performing sector this year, its future may depend on how much high oil prices can counteract the costs of pivoting out of Russia.
The unintended consequences
This is the real doozy. To a degree, we don’t know what we don’t know. And when investors are faced with a great deal of uncertainty, they tend to sell first and ask questions later. It’s understandable: War is frightening, and this particular situation feels especially unpredictable. Plus, the Russia boycott has shown just how quickly the world can cut you out of the financial system, and some think that may lead to the rise of an alternative financial world order. No big deal, right?
My view: There will likely be unintended consequences from this crisis, and the nature of unintended consequences is that they’re…unexpected. However, there are ways to position your portfolio for the unexpected. Focus on your needs and goals first. Then, remember to diversify (or spread your money across multiple assets), so your risk isn’t too exposed to the fortunes of one stock or market.
While it’s natural to think about the worst-case scenario, the best investors prepare for all scenarios. And remember: you — and your portfolio — are likely more resilient than you think.
*Data sourced through Bloomberg. Can be made available upon request.